Daniel Borenstein: Time for CalPERS to finally get real about life expectancy

Posted:
01/17/2014 12:37:48 PM PST

Updated:
01/17/2014 01:57:52 PM PST

State and local governments face more pension rate increases as the nation's largest retirement fund continues to fix its flawed accounting, this time by acknowledging that future generations will live longer.

Given constant advancements in medical science, that might seem obvious. But the California Public Employees' Retirement System hasn't previously factored future mortality improvements into actuarial calculations. As a result, it has not collected enough money to pay pensions when workers retire.

The fix, which the CalPERS board will consider in February, would further drive up rates for public agencies, which already face recent changes to correct for the system's unrealistic investment return assumptions and a dangerously slow paydown of debt.

Chief Actuary Alan Milligan's mortality change recommendation will probably trigger calls for delay from some labor leaders and local government officials. But postponement would continue the pension system underfunding and push more costs onto future generations.

The recent and proposed changes are essential, long overdue and, if anything, don't go far enough. But each adjustment brings the retirement system closer to properly pricing pensions.

With the changes, the state's pension cost for most general workers, for example, would increase from the current 21 cents for every dollar of payroll to about 32 cents by 2021, a 52 percent increase.

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It's very costly. But if employers offer workers pensions, they should responsibly fund them rather than building debt that necessitates decades of tax increases or service cuts.

The City of San Jose has a separate, self-funded retirement system, but most Bay Area public employee pensions are part of CalPERS.

The mortality issue exemplifies how CalPERS has set the rates it charges too low. Retirement systems are funded by contributions from employers and usually employees, plus investment earnings. Accurately projecting how long people will live is critical to setting those contribution rates.

Currently, CalPERS studies the mortality data for its members every four years and from that projects how long retirees will live and receive benefits. But those numbers don't account for the expectation that people will live longer in the future; it only considers how long they've lived in the past.

Milligan recommends that CalPERS use past increases in life-expectancy to extrapolate future increases. That would mean projections of longer retirements, and, hence, higher current contribution rates.

Milligan deserves credit for instigating changes after witnessing the devastation of the Great Recession. Since becoming chief actuary in 2010, he has seemed determined to ensure CalPERS does not drop off a financial cliff.

He's working with a board of labor representatives and elected officials who depend on union contributions for re-election. They know rate increases leave less money for salaries and other benefits. So change has been incremental.

In 2012, the CalPERS board lowered its investment earnings forecast from 7.75 percent annually to 7.5 percent. The lower the forecast, the more money the system needs up front.

CalPERS' own numbers indicate that reduction didn't go far enough. Milligan had recommended lowering the forecast to 7.25 percent. His analysis shows that the system has only a 50 percent chance of meeting the 7.5 percent target.

In 2013, the board confronted the slow repayment of debt created by investment losses and past underfunding of the system. At the time, CalPERS had only about 74 percent of the funds it should have.

Milligan determined that another economic downturn could leave the pension system dangerously underfunded. So the board sped up debt repayment by again raising contribution rates. That reduced future risk but still left the system vulnerable.

Now Milligan urges the board to confront the mortality issue. The devil is in three details. Milligan recommends projecting mortality rates 15 years into the future, but gives the board a 10-year option. He proposes phasing in the resulting rate increases over five years, but leaves the board a seven-year alternative.

Finally, any increase in life expectancy will create more debt because past collections have not taken the more-realistic projections into account. Milligan recommends that state and local governments pay off that debt over 20 years, but hangs out an irresponsible 30-year option.

Each alternative would kick the can further down the road, driving up future costs. If the board is serious about fixing its accounting, it should do the job right by adopting Milligan's recommendations.